June 11,2011

The following article is called The Coming Influence of the Four D’s. The “four D’s” are the dollar, debt, deficits, and demographics. Written Feb. 4, 2005.



We are about to enter a new era. Things will begin to change progressively over the next ten years and affect every aspect of our lives. This will be, the decade influenced by the four D's.


The first D is the dollar. The dollar should continue to decline, most likely, in an orderly way for years to come. Economics dictate that dollars that have been spent abroad must ultimately return to these shores and be spent here. The result will be huge increases in US exports and Tourism, as foreigners compete for cheap American goods. (The dollar’s recent 2011 lows coincide with record levels of exports.)


While this will lead to higher prices of many goods and services to US Citizens, the ability of the US to increase production to meet this demand should mute the price increases to some extent. Meanwhile, US import industries will suffer, and American travel abroad will slow markedly. So, it will depend on who and where you are in the economy that determines whether you will gain or lose by the falling dollar. But one thing is for sure; the overall standard of living in America will decrease.


The second D is for deficits. No one talks about budget surpluses any longer. Given the absence of government spending limits, the ongoing war, the prospect of further foreign entanglements, and greater demands for entitlements—the only question is how big deficits will be.


There are three ways to finance a deficit: Raise taxes, borrow (by issuing more government bonds), or increase the money supply to pay the bills (inflation), which amounts to an inflation tax.


Which of these the government chooses will determine the economic consequences. Borrowing affects interest rates to some degree, which affects us all. It amounts to a claim on the American tax payer, since ultimately it is the tax payer that is the guarantor of Government debt.


Choosing to increase taxes or inflate would be far more damaging than borrowing since higher taxes decreases growth and inflation robs individuals of their purchasing power . Chances are that in the not so distant future, all three of these choices will come into play. So watch the size of the deficit as an early warning sign of possible higher interest rates, higher taxes, and higher inflation. (All three of these threats are at our doorstep today.)


The third D is for debt. While the amount of consumer debt has been growing progressively, so has wealth. Up to this point household debt has not been a major factor, and I doubt that it will be in the future. But government debt is another story. The present National Debt has recently passed seven trillion dollars. Given inevitable future deficits, this figure will progressively grow. (It has doubled to 14 trillion today.)


Even still, this is not our major problem; our real problem is the unfunded liabilities. The promises of Social Security, Medicare, and Medicaid are estimated to be in the 60 to 70 trillion dollar area. (77-80 trillion is the present estimate.) The promises are there, but the money is not. Where will it come from? Most likely, the usual suspects: higher borrowing, higher taxes, and higher inflation. (And now, thanks to the Tea Party, we see cuts in government spending as a possible solution.)


The final D is for Demographics. World population is rising, and capitalism is spreading throughout the world, replacing communism and socialism at a furious pace. As people learn to produce more, they will need and want more commodities. We are already experiencing the first stages of an increase in demand for commodities.


Above and beyond the increased demand coming from China, India, and Eastern Europe, we have a new source of demand -- investment demand. It has been recently reported that Pension Funds, which hold 25 trillion dollars of investable funds, are looking to diversify by buying commodities. Because of the new investment demand, there are funds being developed that buy commodities and issue shares against them. (ETF’s have since been created to allow funds and the individual investor to participate and accumulate commodities.) Pension funds are looking to buy these commodity funds, which will in turn, lead to commodity funds buying more commodities. Look for higher prices and shortages of commodities continuing, and prepare accordingly.


The developing commodity shortage is nothing compared to the much more serious doctor shortage we are about to face. Consider the prospect of 77 million Boomers with blank checks in their hands for medical care. It is already getting harder to get a timely appointment with a doctor. With the aging of Americans, will come greater shortages of doctors and nurses, and non-critical medical problems will go on the back burner. Prepare to wait in line for good medical care.


Demographics will drive another area -- investments. As the majority of Americans get older, their investment goals will change. Keeping money will become more important than making money. This should lead to, and probably already has, less demand for stocks and greater demand for bonds, money market funds, and cash. This could explain why the stock market has gone sideways while the bond market has remained stronger than anticipated. (Trillions of dollars remain on the sidelines and have not returned to the stock market, while more money has gone into the bond market confounding all that have been predicting higher interest rates.) Values are changing, and with changing values come changing markets. History in the coming years WILL NOT repeat itself.


All these observations and forecasts are tempered by one fact—individual choice. At any time, we as a nation can face our problems which appear inevitable and solve them. The fact that the nation is in a very public battle of ideas today, is a positive thing. As the “great Philosopher” W. C. Fields once quipped, "There comes a time when a man has to take the bull by the tail, and face the situation." The next decade I’m afraid, will be such a time.



Market Update:


In keeping with the 4 D theme, which was written years ago and has come to pass, when I look forward, I see 3 of the D’s resolving themselves. In other words the dollar is stabilizing, debt is being reduced by the private sector, and being slowed by the public sector worldwide, as deficits are likely to fall. An interesting fact, that most are not aware of is that American government spending fell year over year by more than 7%. Government employment is slowly being reduced. And this, I believe is just the beginning of the reversal of the trend of at least of 3 of the 4 D’s.


The one D that will not reverse is Demographics. This D is set in stone. Here is the one area that I want to take a position in for the longer term. Health care must change, and I see it changing toward managed care by the private sector within the Medicare structure. One such change is Advantage Care, which is a government/private option.


Under this new option, the government sub-contracts the task of care to private management firms. Humana is one such firm and they are just off their all time high. I am following this stock as a possible candidate to purchase if the market sells off, and takes Humana with it. It looks to have excellent long term positioning in this space.


I want to touch on a point about debt default, once again. There is no one I know of that is advocating defaulting on the interest owed on bonds held by anyone, let alone the principle. The interest payments are covered by over ten times the amount of receipts coming in monthly due to tax collections. A default on new government spending and payments to bureaucrats is what is being called for -- not debt. 25% of bureaucrats make more than the President of the United States. Benefits and wages paid to government employees are outrageous. It is these payments along with other wasteful spending that need to be defaulted on. They are promises made that should not be kept.

Much of the projected deficits are promises of new spending that if not spent will postpone or eliminate new government projects. There are plenty of places to cut. We do not need to start with interest payments, military pay, social security payments, or Medicare as the scare tactics allege. Debt default is not an option. Defaulting on recently passed, and newly promised government spending IS. And, of course, the terms of Medicare and Social Security, must be changed if these programs are to survive.


The markets have responded to my past concerns with a six week decline. I expect this to continue throughout the summer. As it does I will be looking to re-enter the market at lower prices. Until then I remain in 100% cash and cash equivalents.